Preparation for the end of LIBOR
The London Interbank Offered Rate (LIBOR), traditionally a key interest rate benchmark used to price credit contracts and derivatives throughout the global financial system, is being phased out. The UK’s Financial Conduct Authority (FCA) and the Bank of England have stated:
“The LIBOR benchmark relies on estimates from banks of their borrowing costs in markets which are no longer active, so is not considered sufficiently robust or sustainable given its widespread use. The FCA has secured agreement from banks that they will keep contributing to LIBOR until the end of 2021. This will give users time to switch to alternative rates before LIBOR is discontinued. Continuing to rely on LIBOR after this point will create a number of risks to firms.”
UK and international regulatory bodies have confirmed that this timeline will stay in place despite disruptions caused by COVID-19. This may require some entities that still rely on LIBOR to step up the pace of their preparations for completing the transition.
The Financial Stability Board (FSB), an international body of central banks and finance ministries, recently published a transition roadmap for firms with exposures to LIBOR. Key recommendations in the roadmap include: “By the end of 2020, firms should be in a position to offer non-LIBOR linked loans to their customers. By mid-2021, firms should have established formalised plans to amend legacy contracts where this can be done and have implemented the necessary system and process changes to enable a transition to robust alternative rates. By end-2021, firms should be prepared for LIBOR to cease.”
The impetus for ending LIBOR was its manipulation by some large international banks, which came to light in 2012. New Zealand’s Bank Bill Benchmark rate (BKBM), which has a role in New Zealand that is similar to LIBOR’s internationally, was not subject to these problems and will continue to function as the main benchmark interest rate in New Zealand. The New Zealand Financial Markets Association (NZFMA), in consultation with industry, is making improvements to the benchmark regime to ensure that BKBM remains fit for purpose and meets international regulatory guidelines.
Part of these reforms to New Zealand’s benchmark regime is the selection of the OCR as a fall-back benchmark interest rate for BKBM. The Reserve Bank supports this. The NZFMA is developing an OCR Compound Index and calculators to facilitate this new role of the OCR, and has announced that these will be available by the end of 2020.
The International Swaps and Derivatives Association (ISDA) recently released new documentation that will help ease the transition from Interbank Offered Rates (IBORs) to alternative risk-free rates. The Reserve Bank has signed the ISDA’s ‘IBOR Fallbacks Protocol’. As a market participant this is an important step for the Bank to support an effective and efficient transition away from LIBOR and other key IBORs by the end of 2021.
For the transition away from LIBOR to go smoothly, it is essential that preparations stay on track. New Zealand’s banks and other financial market participants broadly recognise that the total transition away from LIBOR is a complex undertaking, but there is a wide spectrum of preparedness for the transition. In light of these complexities, the Reserve Bank expects all regulated entities to continue with preparations so they will be well placed to manage the end of LIBOR. Lenders need to work with their customers to make sure that best practices are followed as legacy products are revised, and that entities understand any exposures they have to LIBOR and how the changes will affect them so they can operate confidently post-LIBOR.